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Markets in June saw some notable volatility when the outcome of the European Union referendum in the UK confounded most expectations and compounded recent broader uncertainties, although there was a significant recovery soon after the initial shake-out. While a degree of stability is welcome there is still much to resolve constitutionally, economically and politically, and so we are re-positioning portfolios a little further to reflect the probable longer-term implications rather than a range of short-term potential outcomes.
The UK voted to leave the EU with a decent turnout which was 72% nationally and mostly lower in the three main regions that voted to remain (London, Scotland and Northern Ireland; Gibraltar also understandably wished to stay in the EU). There was a clearer majority, by 52% to 48%, than most polls or bookmakers had anticipated even if it might not be seen as substantial enough for such a major change. It will take some time to establish how the UK goes about invoking Article 50 of the Lisbon Treaty to leave, if it ever does, when it would happen, who would lead, how parliament would vote, what Scotland could do under the Sewel convention, if there would need to be a further referendum, and how the EU itself will respond.
For now there is a political morass with economic implications but no financial crisis. The Tory party has split, as it is prone to do over Europe, and the Labour party has started to implode, while the SNP and Sinn Fein are looking to benefit from the issues in Scotland and Ireland.
The continued uncertainty is likely to have an impact on consumer confidence, although there have been contradictory initial indications on that, and on future investment into the country, which had already slowed. This would lead to a drop in the level of economic growth and might trigger a short recession, which sadly would hurt many of those who have felt economically disenfranchised and voted in protest. One can only hope that a new government addresses the impact the sluggish recovery has had on certain industries or areas, which has worsened social inequality and the issue of immigration (which is likely to increase in the short-term if the economy holds). There will be an impact on financial services in the City of London, which have made a significant contribution to recent economic growth.
The sharp fall in Sterling on the currency markets will provide a boost to exporters from extra competitiveness, although many companies will say that market stability is more helpful, and will also enhance profits and earnings from the translation of overseas earnings (one of the factors helping the FTSE 100). The weaker currency would also lead to higher prices on imported goods and thus add to inflationary pressures, although the Governor of the Bank of England, Mark Carney, has indicated that interest rates are more likely to be cut, as part of his commitment that the central bank will take whatever action is needed to support growth.
There are of course implications for other countries in the European Union, which might fragment or might yet consolidate further; the recent more encouraging level of economic growth may falter, although again there will be a boost to exporters from a weaker currency as the euro has slipped on the various concerns. Italian banks have been under pressure and are being re-financed. The election in Spain on 26th June at least proved positive in the higher backing for the ruling Partido Popular, even if it is still short of an overall majority.
The initial market reaction after the UK vote suggested there would be an impact on the US, the strength of whose economy will be key both for the rest of the world and the outcome of the presidential election in November. The Japanese Yen strengthened given its appeal as a safe haven, which has impacted the country’s exporters and the stock market. Countries in Asia, which have often historically been at the centre of economic or financial crises, might instead offer a relatively solid outlook, for which continued sound management of the Chinese economy will be a powerful factor. The recovery in commodity prices has also helped a number of emerging markets.
Over the course of June the FTSE 100 managed a rise of 4.4% to close at 6504, driven by the overseas earnings of many constituents and helped by certain sectors; there has been a wide divergence since the vote in sector returns, with tobacco and pharmaceutical shares in demand while housebuilders, property funds or companies and banks have suffered. These sectors contributed to the fall in the FTSE 250 Index of mid-sized companies of 5.3% while the FTSE SmallCap Index, also more dependent on the UK economy although not entirely so, was off 2.7%.
In the US the S&P 500 index was up by a minimal 0.1% and the Dow Jones Industrial by 0.8%, while the technology-oriented NASDAQ index was down 2.1%; the strength of the US$ enhanced returns for investors in Sterling terms. The EURO STOXX 50 fell 6.5% in the month while European smaller companies as represented by the Euromoney index showed a gain of 1.8%. In Japan the Nikkei 225 index fell by 9.7% under pressure from the stronger Yen, which at least improved any unhedged returns for investors overseas. The MSCI Emerging Markets index in US$ rose 3.3% with the Brazilian market up 6.3%.
In the bond market the UK 10-year gilt yield fell sharply to 0.87% from 1.43% and the total return for the FTSE Gilts All Stocks was a substantial 5.6% and inflation-linked stocks did even better. The yield on a two-year gilt was all but negative for the first time after the Governor’s comments on 30th June. The German 10-year bund yield dropped from 0.14% to -0.13%; There are now some $11 trillion of sovereign bonds with negative yields which is why, besides the safe haven appeal, the yield on US 10-year Treasuries is attractive, even down from 1.85% to 1.47%.
Sterling fell sharply against the US dollar to close 8% down at a rate of $1.33:£ (it had touched $1.50:£ just before the vote) while it also dropped 8% against the euro to reach €1.20:£. The Yen rose 7% against the US$ and so 14% against Sterling, for which the UK’s twin budget and current account deficits remain significant issues.
The price of gold rallied by 8% in the month to reach $1322 per troy ounce and the price of silver, usually volatile, rose 17% while other metals were also higher, including the bellwether copper by 4%. The price of a barrel of Brent oil was little changed at $48. Soft commodities were mixed: corn and wheat weakened, coffee and sugar rose. The Vix index of volatility was up by a tenth in the month.
We had positioned portfolios defensively for broader concerns even if they were not specifically set for a vote to leave. We are re-assessing each individual holding as we re-evaluate the outlook. We are making some changes to reflect the weaker prospects for the UK currency and sectors such as property, while looking for resilience in global income shares, Asia and assets such as infrastructure.
Julian Cooke – Investment Director 1st July 2016, Vintage Asset Management
All views are the authors own and do not represent those of SG Financial Services Limited.
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DISCLAIMER: Any forecasts, figures, opinions or investment techniques and strategies set out, unless otherwise stated, are Vintage Asset Management’s own. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. They may be subject to change without reference or notification to you. The views contained herein are not to be taken as an advice or recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate and investors may not get back the full amount invested.
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